Default Premium

Categories: Banking, Metrics, Investing

Babysitters often vary their rates on a scale depending on how problematic their clients’ children can be. The well-behaved kids get a price break; the mischievous kids cost a premium.

Borrowers get similar lensing. The ones who have "enough" cash flow pay less interest than the borrower with a history of lateness and defaults and convictions (not the moral/ethical kind). This extra charge is referred to as a "default premium." That is, lenders worry more about deadbeatism...the "I can't pay my bills" issues, with bad credit risks. So, of course, they charge those risky borrowers more than they would, say, Bill Gates, were he to ask to borrow dough.

In spite of being in debt for $20 trillion, the U.S. Government sets the bar for any other borrowers, and all corporate debt is priced at a relative premium in basis points above the closest benchmark U.S. Treasury bond.

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